Stepping Up to the Gaming Table

Listening to critics bemoan sluggish demand trends in gaming equipment hearkens back to tech bears who complained of saturated demand for wireless handsets just before camera/multimedia versions came out. Sure, it's hard to get rich selling slot machines now, as a changeover from coin operation to paper tickets winds down, and new gaming venues take time to get up to speed.

But catalysts for the next upturn are already taking shape and by the time they solidify, gaming-equipment stock valuations may not look as reasonable as they do now.

Geography

New venues burst onto center stage this week as Steve Wynn boldly predicted the new Wynn Resorts Ltd. (NASDAQ:WYNN) casino in Macau would be profitable on Day One and contribute to its progression beyond a Chinese gaming haven into a full-blown resort destination.

Wynn and Las Vegas Sands Corp. (NYSE:LVS), have aggressive plans for Macau and the opportunity to sell gaming equipment for the new properties slated to open there is clear. It sounds like a cliché — better to sell tools to gold-rush miners than dig on one's own — but sometimes, clichés can pan out.

Along those lines, there are other venues gearing up to different degrees.

Investors were disappointed in California when the Legislature failed to approve gaming compact extensions signed by the governor before the session expired. But eventually, they're likely to get over it, as all the compacts remain pending for the next session, which begins in January. Meanwhile, Pennsylvania recently authorized placement of about 61,000 new slot machines. Broward County, Florida, has approved slot placements. And Russia is poised to add many more machines in the years ahead.

Technology

As to technology, the switch from coins to tickets was nice, but it's far from being the last word on progress.

Video slots have been gaining ground against wheel-based machines. This is more than a cosmetic move as video allows for much greater flexibility.

Players now have more choices in terms of how many "credits" they'll bet and how many different payoff configurations they're willing to buy: instead of images having to only align on the traditional horizontal center line, users can opt to add additional horizontal pay lines, diagonal pay lines, and lines that zig and zag in all sorts of directions.

Additional wrinkles include the player's ability to stop the "spin" at any time, and the increasingly popular bonus rounds consisting of interactive games that allow players to dramatically increase their win totals. Also gaining ground are multi-player games with jackpots that grow based on the actions of the community of players. And new machines allow players to choose whether a credit will cost a penny, a nickel, a quarter, a dollar or five dollars.

Variety of look and feel is another factor that helps keep games fresh and appeal not just to hard-core gamblers but even to casual casino visitors who might not spend so much on the floor, but could wind up spending a lot elsewhere in a multi-faceted resort property. Downloadability makes it easier for casino operators to maintain freshness.

In an interesting twist, Shuffle Master, Inc. (NASDAQ:SHFL) has an electronic version of a card-based table game, where an on-screen dealer interacts with players in various locales, including states where table games are not legal — something that can occur since the absence of a live local dealer causes the games to be classified as machine based.

Baggage-handling

Despite the geography- and technology-based opportunities, it's not easy now to warm to these stocks.

Shuffle Master became very debt heavy as it acquired its way beyond its roots in automated card-shufflers.

WMS Industries Inc. (NYSE:WMS-OLD) still needs to beef up the back-end that serves its multi-player participation games.

Following revenue recognition problems under prior management, Bally Technologies Inc. (NYSE:BYI) still needs to file restated financials. As if that's not enough baggage, it just filed a patent infringement suit against fellow gaming-equipment maker International Game Technology (NYSE:IGT).

Both International Game and Progressive Gaming International Corp. (PGIC) are feeling bottom-line pressure from the current sluggish demand trends.

Multimedia Games Inc. (NASDAQ:MGAM) does not participate in the major resort destinations and is highly vulnerable to the often complex regulatory issues impacting game classification at Native American casinos, not to mention advocacy on the part of a major shareholder for measures to "maximize shareholder value."

Earnings estimates have been trending generally lower among this group.

Silver lining

Despite the baggage these stocks carry right now, analysts are reasonably constructive about their prospects. Table B aggregates individual ratings into weighted average scores, ranging from 1.00 (maximum bullishness) to 5.00 (maximum bearishness).

Table C shows, for each company, how high a five-year earnings-per-share growth rate it would take for an investor buying today to break even on the position assuming, in each case, a future price-earnings ratio that is 25 percent above the level we project for the S&P 500, which is slightly below currently-prevailing relative P/E ratios for most of these companies.

Not all opportunities look equally appealing. The Bally Technologies figures must be taken with a grain of salt until restated financials are presented. We wouldn't bet the farm on the Progressive Gaming growth-rate projection until we see a bit more progress along those lines. And investors in International Game Technology still have to digest the impact of the lawsuit just filed by Bally.

On the whole, though, most stocks do seem to enjoy reasonable margins for error between the break-even and projected growth rates. The same holds true for the group as a whole, when we consider market capitalization weighted averages. And indeed, given all the timing and market share uncertainties among the individual players, buying the group may be the way to go for those inclined to step up to the table.

At the time of publication, Marc H. Gerstein did not own shares of any of the aforementioned companies. He may be an owner, albeit indirectly, as an investor in a mutual fund or an Exchange Traded Fund.

Note: This is independent investment and analysis from the Reuters.com investment channel, and is not connected with Reuters News. The opinions and views expressed herein are those of the author and are not endorsed by Reuters.com.

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